He said that the thing to do was to save the other trust companies and prevent general disaster.

—Herbert L. Satterlee, J. P. Morgan’s son‐in‐law and biographer¹

The failed corner on United Copper and the troubles of a few national banks a week earlier were but early tremors of the financial volcano that erupted on Monday afternoon, October 21. Twin shocks came in rapid succession.

First, after a meeting of the board members of the Knickerbocker Trust Company, the public learned that Charles T. Barney had been asked to tender his resignation. The week before, depositors had run on three banks affiliated with Heinze and Morse, all of which had appealed to the New York Clearing House (NYCH) for aid and received it (subject, of course, to the defenestration of Heinze, Morse, and their associates). The Knickerbocker had been one of three trust company members of the NYCH and had observed the reserve and reporting requirements. Thus, Barney appealed to the NYCH for rescue assistance like what the ailing banks received. However, the clearing house demurred, saying that “the advance of money for the protection of depositors is limited to its own members.”² Given the practice of the NYCH of ousting management of distressed institutions, it seems likely that Barney’s resignation was engineered by Knickerbocker’s board in a final effort to placate the clearing house leaders.

Shortly thereafter, the National Bank of Commerce, the clearing house agent for the Knickerbocker, announced it would no longer clear for the trust company.

The End of the Clearing Relationship

The bank’s announcement was a shocking development. To terminate a longstanding relationship as clearing agent for the Knickerbocker was a serious—albeit ambiguous—signal about the Bank of Commerce’s confidence in the Knickerbocker’s ability to fulfill its payment obligations. Was the Knickerbocker insolvent? What did the Bank of Commerce know that others did not? The termination completely severed any connection of the Knickerbocker with the Bank of Commerce and the NYCH; and it dashed any hope that the NYCH might assist the Knickerbocker in the event of trouble.

The passage of time makes the motives of the National Bank of Commerce difficult to parse. Conspiracy theorists would later assert that this was part of a coordinated action by incumbent banks to discipline the Heinze‐Morse circle and/or the insurgent trust companies.

However, a recent New York law may have spurred the Bank of Commerce to act. Before 1907, banking law held that clearing agents had a priority claim on funds held on behalf of a failed institution; this had meant that the clearing agent could use those funds first to offset any obligations from the client to the agent. Then in February 1907, the New York legislature passed the Saxe Act, which amended banking law to direct the receiver in bankruptcy, not the clearing agent, to control such funds on deposit with the agent.³ In short, the new law motivated clearing agents to be more conservative about which clients they served. Under the new law, if the Bank of Commerce had any outstanding claims against the Knickerbocker, it would now need to stand in line with all other creditors during a lengthy resolution process. Thus, the bank’s decision to decamp from the Knickerbocker at the first whiff of trouble may have been an unintended consequence of the new Saxe Act.

According to a contemporary account, the action of the Bank of Commerce “came as a complete surprise.”⁴ The Wall Street Journal reported that before the National Bank of Commerce had severed its relations with the Knickerbocker Trust Company as its clearing house agent, the bank had requested a loan from the clearing house committee on behalf of the Knickerbocker, which request was denied.⁵ Thereafter, the Bank of Commerce issued its notification in an unusual way. Typically, a clearing house member would send a card over to the clearing house, which would then deliver such news to all other member banks. In this case, the Bank of Commerce sent its notice directly to each bank member of the NYCH via messenger. Upon this notification, the member banks were compelled to continue clearing for the Knickerbocker only for the next 24 hours.”⁶ By going directly to the members of the NYCH, Bank of Commerce started the 24‐hour clock immediately, reducing the exposure of the NYCH. Upon the news, the Knickerbocker’s officers released a statement, saying: “Following the practice of other trust companies the Knickerbocker Trust Company has this day arranged to clear over its own counter.”⁷ This meant that any inadequacy of Knickerbocker’s cash reserves to settle payment obligations would be a risk for Knickerbocker, not the NYCH.

The decision of the Bank of Commerce to cease clearing for Knickerbocker proved to be a significant step toward the Panic of 1907. Harry Davison, at the time a vice president of First National Bank (and who, a year later, would become a partner of J.P. Morgan & Co.) deemed the Bank of Commerce’s decision “clumsy … ill‐timed … a deplorable lack of cooperation.”⁸ On the other hand, Professor Sprague rendered a more benign judgment: “When all the circumstances are considered, however, the failure of the clearing house authorities to take any action was doubtless the most natural course, and though unfortunate in its consequences, can hardly be regarded as blameworthy.”⁹

The Resignation of Charles Barney

The explicit connections between Barney and the events of the preceding week remained unknown, but the implications were made clear in another statement released by the Knickerbocker’s board:

In view of the fact that Mr. Barney’s outside interests had become greatly extended, and in view of his personal position in the directorate of certain institutions recently under criticism, in particular because of his connection with Mr. Morse and some of Mr. Morse’s companies, he has decided that the best interests of the company would be served by his resignation, although he had no loans with the Knickerbocker Trust Company.¹⁰ (emphasis added)

In addition to resigning from his position as president and director, Barney also submitted his resignation from the National Bank of Commerce, the clearing house agent for the Knickerbocker. At a meeting held at the Knickerbocker’s main offices at 66 Broadway, another board member, A. Foster Higgins, was elected to replace Barney immediately.¹¹

Despite the evidence to the contrary, Charles Barney continued to defend both himself and the Knickerbocker. “There is not the slightest truth in any report that I was forced out of the company by the clearing house commission or by the action of the Bank of Commerce.”¹² Regarding the presumed ailing condition of the Knickerbocker, Barney said, “Nothing could be more absurd. The company was never in a stronger condition. It remains next to the largest in the city and as sound as any. There is not the slightest question of its entire solvency.”¹³ It was reported that the accounts of the Knickerbocker had been reviewed by state banking examiners as recently as two weeks ago, and that they were then reported to be sound.¹⁴ Moreover, the firm had announced plans in August to spend an estimated $3.5 million for the construction of a new, lavish, 22‐story office building at the corner of Broadway and Exchange Place.¹⁵ Nonetheless, the Bank of Commerce’s announcement compelled the Knickerbocker not only to dismiss Barney but also to obtain emergency cash guarantees elsewhere. “The Knickerbocker has in its own vaults tonight $8,000,000 in cash,” the Knickerbocker’s officers declared. “If more cash is needed it will be immediately forthcoming under the guarantees.”¹⁶

The resignation of Barney was merely an effect, of course, and not the cause of concern for the condition of the Knickerbocker. The announcement by the Bank of Commerce was far more destabilizing. According to historian Jean Strouse, the National Bank of Commerce was often referred to as J. P. Morgan’s bank; Morgan had been a director of that bank since 1875, and by the time he stepped down as its vice president in 1904, the Bank of Commerce had become the second largest in the country and one of the most stable.¹⁷ By 1907, Morgan remained a director of the bank and a member of its executive board—though as government hearings later revealed, Morgan had spread his attention so widely across boards and underwriting relationships that to attribute every corporate action to his direction implied superhuman qualities. Still, J. P. Morgan’s long association with the Bank of Commerce and the bank’s announcement regarding the Knickerbocker signaled apprehensions about the trust company among the highest levels of American finance that the situation was deteriorating.

Morgan Returns to New York City

As the previous week’s events surrounding the failed corner in United Copper Company stock and the subsequent difficulties of the Mercantile and other banks unfolded, the 70‐year‐old J. Pierpont Morgan was in Richmond, Virginia, attending the Triennial Episcopal Convention. Though his visit focused on the quotidian concerns of the church, his partners in New York had kept him informed daily of market conditions and the anxiety that was brewing among the banks.

In 1907, J. Pierpont Morgan, known to his family and friends as “Pierpont,” was the informal leader of the financial community in the United States. And yet, despite persistent calls for his presence, Morgan resisted any inclination to return to New York in haste, lest his departure before the end of the convention arouse suspicions that a crisis was imminent. By Thursday, October 17, however, two of Morgan’s closest partners, Charles Steele and George W. Perkins, felt that the situation had become acute, and they sent a messenger to press the matter with Pierpont directly. Finally, Morgan relented and without fanfare took a private train back to New York on Saturday evening, October 19. On Sunday morning, October 20, J. P. Morgan was once again ensconced in his “library” at 36th Street and Madison Avenue, a grand repository of the art and priceless manuscripts that were his passion to collect. In the days ahead, this place would become the central headquarters for the coming rescue mission.¹⁸

By Sunday afternoon, the news that Morgan had returned from Richmond had already spread, and a crowd of newspaper reporters formed outside Morgan’s library. Numerous bank and trust company officials came to see him throughout the day, and Morgan spent much of his time trying to get a complete picture of the situation. He assembled two teams, one that consisted of senior bankers, including himself; George Baker, president of the First National Bank; and James Stillman, president of the National City Bank; the other group included three younger, yet highly capable, men: Morgan partner George Perkins; Henry P. Davison, vice president of the First National Bank; and Benjamin Strong, vice president of the Bankers Trust Company.

Morgan carefully reviewed the financial statements of the clearing‐house banks, which showed they were all in sound condition. But the status of the trust companies was less certain. Morgan finally asked his council to assess the trust companies and to determine which should be supported and which others should not.

During the day, Charles Barney, the president of the Knickerbocker, also visited the library, yet Morgan did not meet with him. Perhaps this reflected the scheduling crunch of Morgan’s first day of descent into the vortex of the crisis. Or maybe Morgan had heard enough to conclude that Barney should go, and that the Knickerbocker would fail. Or perhaps Morgan resented the failure of a 1901 underwriting syndicate in Alaska salmon canning, which had been led by Charles Barney and in which Morgan sustained a large loss.¹⁹ Later conspiracy theories about the antipathies of Morgan and his circle toward the insurgent trust companies,^a the Knickerbocker, Charles Barney, and Charles W. Morse took details such as who met with whom as convincing evidence of a “money trust” bent on revenge.²⁰

Around 10 a.m. on Monday, October 21, Morgan drove downtown with Charles Steele to his offices at 23 Wall Street—a building known simply as “the Corner”—where a committee of the Knickerbocker directors personally informed him of their request for Barney’s resignation. As news that the Bank of Commerce would no longer clear for the Knickerbocker rattled over the ticker, Morgan advised the Knickerbocker’s directors to assemble a meeting of their full board that night, review the company’s books, and assess whether they could carry the company through a run. Morgan’s conferences with other bankers continued throughout Monday afternoon. On Monday, Morgan privately told his son‐in‐law, Herbert Satterlee, that he was chiefly interested in the Knickerbocker because of its connections to his old friend Fred Eldridge, but he suspected it was already too late to save it. Satterlee later wrote, “He said that the thing to do was to save the other trust companies and prevent general disaster.”²¹

The Problem of Charles W. Morse

The nagging question that afternoon was why Charles T. Barney, the president of the Knickerbocker, should have been toppled in the aftermath of the Heinzes’ attempted corner of United Copper; Barney was not directly involved in the corner. However, Barney was long associated with Charles Morse, who had been associated with Augustus Heinze. Morse’s two banks, the Bank of North America and the New Amsterdam, had been severely compromised in the fallout from the Heinze copper corner. “[W]hen Mr. Morse was explaining his affairs to the Clearing House Committee,” the New York Times reported, “he told them that they ought to look around in other places too if they were going to push their investigations to the end, and that set the committee thinking. Soon after, stories of the development of the situation in the Knickerbocker got afloat in the financial district.”²² These rumors regarding apparent connections between the Knickerbocker and Morse’s activities gained credence on Monday with the statement from the Knickerbocker board that Barney’s dismissal was caused, in part, by “his connection with Mr. [Charles W.] Morse and some of Mr. Morse’s companies.”

Morse had grown up in Bath, Maine, and through hard work and shrewd dealing had amassed dominant market positions in ocean transportation between New York and New England and in the delivery of natural ice to cities on the Eastern seaboard, which garnered for him the nickname “The Ice King.” Morse’s Consolidated Steamship Company competed directly with railroad transportation from New York to New England and specifically with the New York, New Haven, and Hartford Railroad, in which J.P. Morgan had held a longstanding financial interest. Historian Philip Wood relates that in court testimony some of Morgan’s managers said that Morgan “loathed Morse.”²³ According to Satterlee, Charles W. Morse “was regarded as a dangerous man in banking circles.”²⁴

Unfortunately, Charles Barney had been associated with the unsavory Morse both personally and professionally for many years. For example, Barney was a director in several of Morse’s biggest ventures, including the National Bank of North America and the New Amsterdam National Bank; he also served on the board of the American Ice Company, sometimes called the “Ice Trust” because of its nearly absolute monopoly of the ice business in New York City.²⁵ Barney was also a major shareholder in the Consolidated Steamship Lines, into which Charles W. Morse had merged six coastal steamship companies, thereby dominating all freight and passenger steamship traffic along the Eastern Seaboard.²⁶ Furthermore, the connections between Barney and Morse extended directly to the Knickerbocker itself. By the fall of 1907, the Knickerbocker Trust Company had major holdings in numerous Morse‐controlled interests, including the Bank of North America, the American Ice Company, the American Ice Securities Company, the Butterick Company, and the Clyde Steamship Company.²⁷

Morse never revealed why he may have encouraged the New York Clearing House Committee to investigate Charles T. Barney, but no less than three weeks previously Morse had been denied a seat on the board of the Knickerbocker Trust Company. After acquiring a significant block of Knickerbocker stock, Morse had demanded representation on the board, but the majority of its directors threatened to resign in protest should he be elected. Whatever the motivations may have been, by Monday afternoon the implications of Barney’s and the Knickerbocker’s connections to Morse (and possibly Heinze) were understood to exist. Barney was out and “J. P. Morgan’s bank,” the National Bank of Commerce, had turned its back on the Knickerbocker Trust Company.

Knickerbocker Hopes for Assistance

At 9 p.m. on Monday, October 21, the meeting Morgan had proposed for the Knickerbocker directors was assembled at Sherry’s, a popular and famous restaurant at Fifth Avenue and 44th Street. Morgan, Perkins, and Steele retired to a private room for dinner, while the directors and their friends met separately to consider the condition of the trust company. “At the meeting it became evident that the Knickerbocker situation was pretty desperate and, unless promptly in hand, would certainly cause a run on that company which might spread to others,” Perkins recalled.²⁸ By 11 p.m., nothing had been accomplished; Perkins called for other leading bankers and trust company presidents to join them, while Morgan, who was suffering from a severe cold, returned to his library at 36th Street.

The conferences at Sherry’s lasted until 1 a.m., when the Knickerbocker board decided to open the trust company the next day; if there were another run by depositors, they would keep the Knickerbocker open as long as it would take them to secure additional assistance from other financial institutions.²⁹ It was hoped that there would be enough time for other banks to investigate the condition of the Knickerbocker for themselves and to provide relief.

The Dilemma

The critical question was whether the Knickerbocker was merely out of cash (illiquid) or was unable to meet its liabilities even if all assets were converted to cash (insolvent). Conventional thinking at the turn of the century was that in a panic, illiquid institutions should be supported, and insolvent institutions should declare bankruptcy. The iconic expression of this was Walter Bagehot’s Lombard Street: A Description of the Money Market, published in 1873.

In Bagehot’s day, Lombard Street in London was the center of the international money market, and the location of the Bank of England. Bagehot styled the book as a kind of primer for new professionals on Lombard Street. It was an extended argument in favor of a muscular central bank, one that would serve the liberal (and mercantile) policies of Britain and that would generally create the conditions for economic stability and advancement. An important responsibility of such a bank, he argued, was to fight financial crises by being a “lender of last resort” (LOLR).^b

Bagehot’s advice for such lenders was that in a financial crisis, the LOLR should lend freely to solvent borrowers upon good collateral and at a penalty rate. Consider the three elements of Bagehot’s instruction:

1. Lend freely: Illiquidity is a hallmark of financial crises. When depositors run and withdraw their savings from banks—both the healthy and distressed ones—banks call in loans. Credit, the lifeblood of commerce, stops flowing. By lending freely into the financial system, the LOLR supplies the short‐term funding that banks need and thereby helps to quell runs and forestall the credit contraction that sparks a debt‐deflation spiral.
2. Solvent borrowers upon good collateral: This is a “tough love” policy. To demand good collateral is to guard against losses by the LOLR. And it also means that the LOLR will really support only the solvent institutions and will necessarily allow insolvent institutions to fail, preventing the persistence of “zombie banks” and the misallocation of resources they entail. It has been said that capitalism without bankruptcy is like Christianity without hell.³⁰ A world without the risk of failure fuels moral hazard. Yet allowing some institutions to fail might worsen a crisis. Perhaps some institutions are “too big to fail.” Moreover, judging the value of collateral under crisis conditions is fraught with numerous issues, not least of which is whether the market prices of securities during a crisis reflect the intrinsic value of those securities. In short, always demanding good collateral as a condition of lending freely might prolong the crisis.
3. At a penalty rate: Charging high rates of interest in a crisis may seem like extortion to stressed banks. But high rates may be useful. They discourage opportunists who would exploit the eagerness of the LOLR to lend freely and end the crisis. And they discourage moral hazard by penalizing lenders who were too expansive. Of course, interest rates should always be tailored to the risk of the situation, thus enticing capital to come out of hoarding. Less‐than‐penalty rates might distort the efficient allocation of capital in an economy and/or fuel moral hazard. But setting very high rates might work against the goal of restoring liquidity to financial markets and institutions.

Resolving the dilemma of the Knickerbocker’s financial condition was thus among J.P. Morgan’s chief concerns, and he assigned Henry Davison and Benjamin Strong to examine the Knickerbocker’s books and report back the next day. Under Walter Bagehot’s logic, if they determined that Knickerbocker was sound, Morgan would be justified to find money to keep it afloat.³¹ For a bank to be “sound” meant that the value of its assets exceeded the value of its liabilities, that it passed a fundamental test of solvency.

Davison and Strong faced a nearly insuperable task. For instance, Knickerbocker’s pre‐panic balance sheet showed 76 investments in public securities and numerous private commercial and real estate loans—63 percent of its assets were concentrated in collateralized loans, probably call loans on the NYSE.³² The two men faced a massive valuation exercise with only pencil and paper and none of the modern conveniences such as computers, databases, information retrieval systems, generally accepted accounting principles, certified audits, or bond ratings.